Paul Winkler: Welcome to “The Investor Coaching Show.” I am Paul Winkler. We talk about money and investing and educate because let’s just face it, there is a lot of bad, bad information out there.
Understanding Market Downturns
A lot of times people don’t know what level of education the person is that they’re talking to in the financial world. Quite often they don’t know, “Do I believe this? Do I not believe this?”
I think that if you become educated, you don’t have to know everything, just a little bit yourself, and you can discern between what’s good and what’s bad because a lot of this stuff is common sense. It’s not as hard as they make it out to be.
Now, if they make it out to be really, really hard, you’re dependent upon them. You’re dependent upon their predictions about the future, number one. You’re dependent upon them for just whether they are telling you the truth or not.
This is just the investment industry. This is the financial media. It is everywhere.
So I like to make sure that you get this stuff on your own because then it’s hard to mislead you. That’s my whole philosophy, and I’m sticking to it.
Okay, so one of the things that I want to start off with is to talk a little bit about just some of the stuff that you hear out there, and I want to make it a little bit more understandable as far as market downturns go, because that’s what everybody fears, right? We don’t fear the upturn in the market; we don’t worry about upside volatility. It’s downside volatility that gets us.
We hear that markets are volatile and we think, Oh, volatility is bad. No, nobody complains about the upside version of volatility.
I want to talk about the downside version because that is where we can get in trouble. Because investing, quite often, the problem with it is it goes against our instincts that we’re given, against our God-given instincts, and our fears and the things that cause us to take action quite often. It’s emotional — emotionally driven — a lot of our actions.
We typically do things based on emotion and we justify with logic. It can cause us to do the exact wrong thing when it comes to our money.
What I want to do is I want to just plant some information about investing that I think you ought to know, but things that are going on in current times right now, just to help you put some of the things that we’re hearing in perspective.
Market Forecasters
Now, one of the things that I hear from time to time is, well, people predicting where markets are going to go and what’s going to happen next. Typically, the ones that get the most attention are the ones that are the most dramatic — the predictions that are the most dramatic.
Dan Mannis actually sent me something this week and I thought it would be good to take what he had seen and just talk through some of the points in this particular article.
Now, it was an article that was in the Daily Mail, and apparently, what was being talked about was this guy from JP Morgan. It’s a big investment company, a very well-known investment company, and the headline says, “JP Morgan forecaster issues grim warning about the state of the stock market.”
Now, number one, if we look at the title right here, a forecaster is somebody who is trying to predict the future. What do we know about people that try to predict the future? It’s not a great track record.
I like what Burton Malkiel from Princeton said. He said, “So often these people believe what they’re saying, but the evidence as to the efficacy or whether it actually works is pretty slim.” People that get into the investment industry spend so much of their time trying to figure out where things are going next because they think that’s their job.
The reality of it is that you need to look at the huge pensions.
In studies where they engaged in trying to forecast the future, they found that 100% of the time — one study on pensions found that 100% of the time — when the pensions acted on predictions about the future, 100% of the time they actually hurt returns.
They did not help returns. That should probably be a wake-up call to anybody out there.
Mutual Funds Loaded With Stock
Now, why is that the case? Well, the case is this. Number one, when we look at trying to figure out when the market is going to go down, we have to be right twice.
We can’t just be right once. We have to be right twice. When we predict that it’s going to go down and get out on time, then we have to be right about when it’s going to go back up, number one.
Number two, when we hear this kind of thing, that somebody is predicting that the market is going to go down, one of the things I think we ought to do is look at the mutual funds that are being managed by the company in question. That seems like a good idea, doesn’t it? Are they putting their money where their mouth is?
I did exactly that. I went and looked at the mutual funds that are being managed by this big investment firm, and I noticed something really interesting. They were loaded with stock. They were loaded with stock.
You would think that they would be shorting the market or borrowing the shares, selling them, hoping that they’d go down. They can rebuy them because if it’s really going to crash, that’s how you make money in a market like that.
You can short them, but low and behold, no, they’re holding stocks. A lot of them. And they’ve got a lot of different funds that are investing in the same exact area of the market.
You go, “Well, what’s that all about?” Well, fund companies will do that — not just this one, but many of them. You look at the different fund companies out there and they’ve got hundreds and even one company, well over a thousand mutual funds, and they’ll have multiple funds investing in the same exact area of the market.
Why would they do that? Well, one fund may have a little bit slightly different holdings than the other one, and if it does better than the other ones, they will use that in their marketing and go, “Hey, look, look how good we are. We beat the market with our fund.”
The reality is they may have had six other funds that didn’t come anywhere close to matching market returns, but they’ll talk about the one fund that did.
Now that’s number one.
Which Market is Going Down?
Number two, when we look at somebody saying that the market’s going to go down, you have to ask yourself which market, as I talked about before. Most of the time people are talking about the S&P 500 when they talk about the market or the Dow. Now, the Dow is only 30 companies, so that’s really ridiculous, but they may be talking about the S&P 500, and that’s what they were talking about here, but that’s just 500 companies in one country out of thousands and tens of thousands of stocks around the world in 40, 50 countries.
You look at that and go, “Well, wait a minute. That’s a pretty small group when you think about it,” but it’s what we think of here in America. If they were sitting there talking about what was going to happen in the French market or the German market or the UK market, or the Australian, you probably wouldn’t be paying any attention.
You wouldn’t pick up the magazine, you wouldn’t listen to what the person had to say. You wouldn’t sit there and watch them on TV if they were talking about that.
You have to recognize that they will talk about something that you will listen to, and especially if it’s scary, they’ll really get into talking to you about markets and what’s going on, and they will get your rapt attention if it’s a market that you’re familiar with, okay? We look at that and we say, “Okay, so that’s one area of the market.”
Now, number two, the other thing to think about is this: Let’s say that you have a dip in the market around when somebody makes a prediction like that, then you go, “Whoa, wait a minute, they must be right.”
But recognize that 5% downturns in the stock market happen about three times a year, historically, dating back to the 1950s.
It’s pretty doggone common. That doesn’t mean that the market went down for the year. It could go down in one week by 5%.
Then next week it’s back to where it was before, no problem. Ten percent downturns happen about once a year, so it’s pretty common.
Betting Against the Odds
Now, in the article, there was this comment about a 20% downturn, and you go, “Oh my goodness, 20% downturn. That’s huge.” Well, the reality is, yeah, it is big, right, but that happens once every six years.
Now, that doesn’t mean that you can bank on it like clockwork. It’s going to happen one year and then you’re going to go five years, it’ll be up and then it’ll be down, and then it’ll be up for the next five years. It may be up for 10 years straight and then down a couple of years, and then it may go six years the next time and then go down, and then it may go two years the next time and then go down, and then it may go another nine years and it’s all over the place.
That’s just statistics, and it can really confuse you when you look at them that way. You think about it this way: You have a 17% chance of being right when you predict a market downturn and with just the S&P 500, you have a 17% chance of being right.
If you are right, man, you could make a name for yourself. It’s like a high-odds-against-you bet on a horse race.
But that’s when you get the big money: When you go against the odds and you really step out there.
That’s when the big money comes in for horse races, and it can be the big money for stock markets. Now, so he’s looking at the S&P 500, which is one out of 12 asset categories that I would have in a portfolio. Would I own that in a portfolio?
Yeah, but I’d have only about 5% of my money there. I wouldn’t be putting in a whole lot. Five to 7% of money is typically about as much as you’ll see in a portfolio that I would put together. Unless you don’t have a lot of options in your 401k, I might go a little bit higher than that, but I just want you to get the idea that it’s not a huge percentage of your portfolio in that particular market segment.
Now, is the S&P 500 high compared to historic norms? That would be a question you might ask. Is it high? And you go, “High compared to what?”
Well, compared to earnings is what I would look at and compared to the book value or the assets of the company, that’s something I would look at. Technically, if we look at it right now, it is higher than historically normal, but is it outlandish? No.
It’s typically about 16 times earnings. Last I looked at it, it was around 20, around that range.
Now, you look at that and go, “Whoa, that’s high. That could come down.” That just means if I turn that ratio upside down, that the earnings yield is lower. The reason is because we’re looking at an area of the market that is less risky historically.
Now, what happens if I’m only in just that area? That’s a tremendous risk, but if you compare it to other areas, it’s less risky than other asset classes, other areas that we would have in a diversified portfolio.
U.S. Market Productivity
Now, we look at that and go, “Okay, so that’s a little bit high compared to historic norms, but why?” Well, that’s because if you look at the bottom number, earnings, earnings could grow rapidly.
Why? Productivity. If you look at U.S. stocks right now, U.S. markets are actually about 5% more productive. Then I heard this statistic this week, the U.S. market has 5% higher productivity than other markets around the world, which would explain why other markets around the world aren’t selling for as high.
If we look at other areas, now, this is the same thing that happened. I remember when computers became ubiquitous. Everybody owned one, right?
Well, if you looked at the computers that we were running, we were starting to run Windows software on our computers here in America. Around the world, they were using DOS. They were still using the DOS system, which was pretty antiquated.
Is it unusual for international markets to be a little slow at picking up on productivity changes? Not historically.
You look at that and go, “Okay, so that would explain why US stocks might be higher — because we are implementing the new technology that is coming in rapidly right now.”
I mean, look at it in videos and their stock with chips and AI technology. Regardless of what you think about all that stuff, it has really been helpful. I heard somebody say this week they were talking about people not worrying about losing their jobs to AI, but more worried about losing their jobs to someone that knew about AI and worked with it better than they do. I thought that was an interesting observation.
Anyway, so we look at that and we go, “Okay, so we have this person trying to predict where the market’s going to go. Historically, the odds are terribly against them on being able to do that.”
Listening to Market Predictions
You go, “Well, where are the odds on that? Why?” Well, one of the things I pointed out to Dan was that if you look at the SPIVA data, the most recent data that I saw on their website was 94.57%, from professional large-cap core fund managers. Those are investors that are managing core funds — core mutual funds that invest in areas of the market.
Like the S&P 500. But 94.57% of them failed to match the return of the S&P 500 over the past 15 years. That’s pretty bad. That’s really bad.
Why would we listen to a fund manager whose odds of being able to predict the future are pretty stink and slim based on history? Why would we listen to their prediction about where the market’s going to go next?
It really gets down to this: It appeals to our desire for a prediction about the future. If you could just tell me where things are going to go next, then I wouldn’t have to worry about it anymore. Well, the reality of it is that most of the things that really move the market in a big way are completely news-driven.
They’re things that you can’t possibly know unless you travel through a time machine. You’re like Biff, and you go and look at the horse sheets. “Back to the Future” joke. It’s just ridiculous that people still try to do this, and they do.
I’m going to walk through what happens in other markets historically, because we talk about diversification here, and I talk about how people are just terribly not well diversified, but let’s talk a little bit about risk and how we actually reduce risk in a portfolio, or how can we reduce risk in our portfolios. What are the things that academic research has shown are good things to do to reduce the risk so you’re not piled all in one area of the market that historically could be very, very volatile?
Okay, so I’m building this case about diversification because we’ll have predictions. People will come out with predictions about what the market’s going to do.
Typically, the most dire predictions, the most scary predictions, are the ones that really get your attention. There are people out there that do that, and one person will be talking about how the market’s going to go down this much, and then I go look at the mutual funds they manage and they hold a lot of stock in them.
Do you really believe what you’re predicting? That’s just mind-boggling to me.
If I really believe something, then I’m going to take action on it, right? Your beliefs and actions should be intertwined.
That’s the way it works, right?
What Are U.S. Markets Selling Right Now?
We look at U.S. markets and say, “Well, what are they selling at right now?” Like I said, I just looked it up during the break and it’s about 20 times earnings. That was about right. But if you look at, for example, value stocks, small value companies, they have about 11 times earnings based on forward earnings right now.
If you look at international value companies, they’re sitting at about nine times earnings, which is way, way less than U.S markets. If we look at it like small caps, it’s about 15 times earnings, and they’re typically smaller companies that will sell for a little higher multiple, and it’s not unusual for them to be at a little higher multiple just because the earnings can grow so fast. They’re small.
A small company can do a lot of things to grow earnings rapidly, so that would be the reason for that, but it’s still not high.
I mean, you look at it based on history, and it’s right about normal where it has been. You look at, oh, let’s see what else, large value stocks. Large value stocks are sitting somewhere in the neighborhood of about 14 times earnings right now, and micro-cap companies, really small companies, about 14 times. So you look at that and go, “Well, okay, that’s nothing.” S&P 500 historically, just to give you a frame of reference, is about 16 times earnings.
So a lot of those numbers were well below that. Now, that doesn’t mean that I am predicting where those markets are going to go or anything like that. It just points out that they’re not ridiculously high and just waiting for some big crash. You have to have an event that tells us that earnings are going to drop precipitously for that percentage that they talk about quite often in these things that you see in these articles for it to happen.
You’ve got to be able to predict something that even the CEOs of the companies don’t know because CEOs of the companies, they’re heavily invested in their own stock usually, and so are the people that work for those companies. And again, we’re talking about an investing company here that also holds a lot of stock, and of course, they’re not shorting their company stock right now or any company stock, or are they shorting anything? They probably have a mutual fund out there that’s doing some of it.
Because like I said, mutual fund companies will have lots of different funds and they will be all investing in the same area, and they’ll just be doing a little bit of different things because if one hits it right now, they can walk around and go, “Man, we are so smart. We’re so good at this thing that we look at the return of this one fund. Look at the return of the one fund that we got compared to the market, and don’t pay attention to the guy behind the curtain. Don’t pay attention to all the other funds that haven’t done that well that we manage, okay?”
So that’s one thing.
Differences in Market Segments
Now, the other thing that I like to look at is what companies are selling for compared to their assets. Now, right now, the S&P 500 is almost at four times asset values, price to book. So you look at that and go, okay, is that higher than normal?
Yeah, it is a little bit higher than normal. But remember, I wouldn’t even predict — I wouldn’t even go venture to predict — that area of the market.
The S&P 500 is overvalued because again, that is a prediction about the future. It’s market timing.
Also, we look at what’s going on right now and the productivity growth that is happening in that particular market could very well justify that level of valuation. But look at other areas of the market.
Remember I said the S&P is about four times? Well, small-value stocks are only sitting at about 1.15 times. They’re much, much lower.
International value stocks are just barely over one times book value, and micro caps 1.68. So we look at these various, emerging markets values at 81 cents. So you look at these markets, international companies in general, and what I would hold in a portfolio is less than one.
If you look at a well-diversified mix between large and small and value and growth in international markets and emerging markets, it’s very, very low. So it’s not sitting at any kind of a huge multiple of book value, okay?
So that right there is number one. You can see just by my naming out those numbers and calling out those numbers and those various asset categories, you see that there are very, very big differences in different market segments at any point in time.
When tech stocks took their big dive in the years 2000 and 2001, value stocks actually went up. Small value went way up in 2001. International went up in 2002, even though large U.S. stocks went down 22%.
Now, we’ll talk more about that in just a second because what I want to do is walk through what has happened historically and make the case that it’s not just stock diversification that we want to make sure that we have. We also want to make sure that we have fixed income diversification, and we’ll talk a little bit about what those market segments do during downturns as well, because all of this is important.
It’s so important to me because when I meet with people and I look at their portfolios, I typically point out to them right away, “You are nowhere near as diversified as you think you are.”
People think they’re diversified because somebody says, “You’re diversified,” and they go, “Well, what is diversification?”
You can own 500 companies in the S&P 500 and say, “I’m diversified if I only own one mutual fund investing in the S&P 500,” because technically that is correct. I’m diversified in large US blend companies, or core companies as they’re sometimes called, I’m diversified because I own all of them.
I could be diversified, quote-unquote, in all tech stocks. I’m diversified in that segment of the market. But the reality of it is I am not diversified when it comes to what a portfolio in my humble opinion and academic research and multiple Nobel Prizes has shown is real diversification. So we’re going to talk about that a little bit more right after this.
Part 2
Paul Winkler: All right, we’re back here on “The Investor Coaching Show.” I’m Paul Winkler, talking about the world of money and investing.
Playing the Market
So, a lot of this stuff that I talk about here on this show is because I like academic research, and it’s just simply because you’re getting out of sight of the sales process. So much of the information when I was a broker we got from people selling stuff or trying to convince us that they had a better system for “playing.” You hear that term all the time, “playing the market.”
And you go, “Well, wait a minute, playing the market sounds like playing the slot machines,” and you’d be right about that. It’s what people often do, and they pass this as investment advice. I just don’t think it’s a very good idea.
If you look at the top mutual funds, and let’s take the top 30 mutual funds from 2003 to 2012, and you look at the rate of return, they had an 18% on average rate of return. You go, “Wow, that’s really good.”
Now, over the same period of time, the market did, yeah, just shy of 10. Eighteen is way better than 10, right? And I’m talking about the market when I say that. I’m using the CRSP one through 10, which is the entire U.S. market — the Center for Research in Security Prices. It’s CRSP — we call it that for short.
Now, if we look at the next period of time, 2013 to 2022, those top mutual funds had a little bit over 10%, about a 10% rate of return, around 10.21%. Now, that’s versus the market at 13.4%.
And you go, “Whoa, wait a minute. What happened to their great skill?”
We find that some funds get lucky over a period of time, but their luck runs out and they don’t repeat, and that’s the problem with investing that way.
Now, we look at, let’s say markets, and we go, “What are markets?”
When I look at large U.S. stocks, that’s the S&P 500, as I’ve talked about lots of times here, but we would look at also small companies, and that would be like the CRSP nine to 10 is what we call it. Now, that would be the smallest 20% of companies.
Dissimilar Price Movement
Now, if we look at the smallest 20% of companies, that’s just a whole different group of companies. A lot of companies, some of you may have heard of, some of you probably haven’t heard of.
But let’s just go back far enough in history to where you don’t remember any of this stuff. So if we go back to 1970 — well, some of you may remember, but I doubt it — for example, if you look at the S&P 500, it went up 4%. S&P 500’s value stocks are measured by the Fama-French Value Research Index. Small companies would be the CRSP six through 10, which is the bottom half of the market in terms of size, CRSP nine and 10. That is the 20% smallest company.
So, I’m just defining this for you more for people that want to really know the nerdy details. U.S. small value is measured by the Fama-French Small Value Research Index, and then the MSCI EAFE, which is large international, and then international dimensional international small is the index for international small companies.
Now that I’ve got the names out of the way, I’m just going to go international small, international large, so on and so forth. The S&P went up 4% that year, but large-value stocks went up 10%. Now, small companies went down 12%. So you’re going, “Well, wait a minute, it depends on how I define the market to say, did the market go up or down that year?”
You see? Now, if I look at 1971, all of the areas of the market went up, but very different amounts. Large U.S. stocks, S&P, went up 14%, but small international went up 68%. Whoa, that’s a big difference.
Next year, S&P went up 14%, and that wasn’t too far off of a lot of U.S. markets, but international large companies went up 31% and another, about 37% for large international, and 64% for international small. Whoa, wait a minute. Wow, that’s big difference, and that’s why you often hear me say dissimilar price movement when I talk about investing.
I want to invest in areas, market segments, that have dissimilar price movement.
They may move in the same direction, but they may move in very dissimilar fashion.
Stock Asset Classes Going Down
Now, if you looked at ’73 and ’74, we had of course the oil crisis — it was a rough period in time — and all of the stock asset classes, all of them, they went down, because it affected all companies around the world in a similar way, because oil was a big way that companies got their energy and they ran their businesses.
It was a big cost of doing business, buying oil, and the embargoes were a problem. Then you also had some inflationary pressures coming into things like that. And isn’t it interesting that we’ve had some talk about inflation, then gold went down?
There’s been some days we’ve had announcements on inflation numbers being a little bit hotter, and then we saw gold go down.
You go, “Wait a minute. I thought that was supposed to be your protector again.” That’s another topic for another day.
But anyway, if you look at bonds those two years, you had about four to five to six, up to 8% return in some bond asset classes that particular year, short-term, very, very short-term. Treasuries in ’75 or ’74 went up about 8, 9%, and they went up another 7% the year after that. Intermediate bonds went up 7.8% in 1975.
Well, that goes a long way into ’73, ’74. Excuse me, let me back up, and just point out that the bonds, whether it be short or intermediate, went up when stocks went down. I want to make the point that they went in the opposite direction that the stock markets did in that particular year.
Now, ’75 was up all the way across the board, but if you look at some of these asset categories like large U.S. stocks went up 37%, but you had a 71% return in micro-caps. So you see, it was very, very different.
The Importance of Being Well-Diversified
Now, if you go to 1977, another good example, somebody goes, “Oh my goodness, my large U.S. stock portfolio went down 7%.” And I’m sitting there saying, “Well, who cares if you own international small, because they went up 74%?” Instead of down, they went up.
So, this is the idea when we diversify — having things that move in very dissimilar fashion.
So, when we look back through history, I’ve been talking about the ’70s here, so let’s go look at the 1980s. Did we see some of that? Yeah, I’ll pick out 1987.
Remember people talking about the big stock market downturn? Most people don’t recognize that in 1987, even though you had this big crash in October of ’87, the S&P 500 actually ended the year up. It actually ended the year up, even though you had this huge crash in the stock market in October of that year.
Now, it only went up 5%, but it went up, and most people remember the 1987 crash, Black Monday, right? Oh my goodness, go read about it. It was horrible, it was scary, and then you look at international markets, it was up 24% for large international companies and 40% for small.
So the point is, this is really where the rubber meets the road in diversification. Now, if we go more into common time, into the more recent period of time right now that most of us are commonly familiar with, if we look at years like 2008, for example, when we had a big decline in the market, the banking crisis and all of that, well, intermediate bonds and five-year treasury notes went up 13%, treasury bills went up about 4.7%.
So if I owned those areas, it wasn’t such a calamity. And that’s the idea. If we look at all these different areas, you can have what Wall Street says, the market going down, and you can have another market actually going up.
And if you’re not in it, some of that risk, you look at that risk that it hasn’t been mitigated, that’s a problem. That’s why it’s so, so terribly important to be well-diversified.
Putting Money Into a Single Investment
Now, some people, what they do is they go, “I just can’t stand the risk at all,” and they go and put money into a single investment. They put it into a bank CD or a savings account or an annuity product, and they don’t recognize that they have just walked away from the very first tenet of investing that they ever learned, which is don’t put all your eggs in one basket.
Then they don’t recognize that if something happens to that insurance company, they could be in a world of hurt.
If something happens to that bank, their money could be tied up, and the reality is banks typically buy each other out, but then all of a sudden you might have your money locked up.
I remember that happening when I first got to town here in Nashville, during the S&L crisis. Boy, I met with a lot of people that were really, really anxious.
I’ll never forget that, and I think that’s a big part of it. I talk about this and I’m thinking, Man, having been in this industry as long as I have, you see things that a lot of younger people that might be out there giving advice on investing have never seen. So, therefore, they’re blissfully ignorant of what the bad is that can happen when the sales brochures don’t actually match up to reality.
So, that to me is super, super important. Now, I had a question that came in this week, and I’m going to actually talk about this coming up next. Somebody actually was at their bank, and I just thought I would talk a little bit about that experience and just walk you through something that I’m seeing a lot of, and you’re probably seeing a lot of, and talk about some of the risks and the problems with it.
Okay, so somebody was asking me a question this week, and I thought I would just run it by you as the audience here, something that we see quite often. A person went into a bank and they said, “Hey Paul, I heard you talk about annuities.”
I thought, Red flag, red flag, red flag. And I had to really, really pay attention to this and make sure that I didn’t do anything that I would regret.
And I said, “You know what? I always like it when my friends call up and tell me what they’re thinking about doing versus what they went and did.”
Banks Selling Annuity Products
So annuity products are being sold quite heavily by banks right now. And the reality of it is that the bank makes more money. It’s kind of a funny thing about banks.
I remember talking about this years and years ago and doing some research on it. And I won’t quote the numbers because they’re probably different now and who knows where they are right now?
But I remember it was really kind of funny because somebody was talking about savings accounts and CDs and those types of things, and talking about how the bank doesn’t charge a management fee and you have no management fees with these things. And I don’t even remember what the context was, but I said, “Oh, well, you need to think about it this way.”
And I pointed out that when you make a deposit to a bank, they’re going to pay you a certain rate of interest on your deposit. They’re going to lend the money back out at a higher rate, right?
Now, the difference between those two numbers you can think of as a management fee. And I remember looking at the differential between what they were borrowing and what they were lending it back out on. And it was pretty significant.
And I remember just walking through that process with somebody and they were just saying, “Whoa. Wow, okay, that’s a big difference.”
Well, that differential between those two can vary from time to time. And the issue that you can have is, let’s say that if a bank is being squeezed and they’re having to pay a higher interest rate on deposits but they’re not able to lend the money back out, or they’re having a hard time lending it out at a higher interest rate, you can have quite the squeeze on the bank.
So they’ve got to find other ways of making profits. And one of the big ways that banks make profits these days is some of them will do managed accounts and those types of things, but a big way that they do that is through insurance products, and annuities are a big one that we see being sold at banks.
Now, a lot of times what happens is that somebody might have a good relationship with a banker and like the banker an awful lot and think, That’s a really, really nice person. And the reality of it is they may be a super nice person, but they may not know a whole lot about what they’re selling. That is what I’ve found.
And this friend of mine is going, “You got to really tell some of these salespeople what they’re really doing.” And I said, “Do you think that they would really change their mind? They have a huge loss on their hands if they can’t sell a product that is one of the biggest moneymakers for the bank or for themselves.”
It’s hard to convince somebody to do something different if it’s in their best interest to keep doing it.
It’s hard to do that.
Annuities as Accumulation Vehicles
Now, one of the things that we find with annuities is quite often they’re used as an accumulation vehicle, and they can be a really bad accumulation vehicle. Now they will say, “We’ll give you returns of the stock market if it goes up. But you don’t have any downside risk if the market goes down,” which sounds really appealing to the general public out there. “I’ve got all the return with no risk.”
But what you’ll find in these contracts is they take dividends out — the return of profits to the shareholders of the companies. If you take away those dividends earnings historically, that’s a huge part of returns. Then they can also cap the capital appreciation or the growth in the stock.
They can only give you so much of that per year. And they can do it by cap rates. They can do monthly caps and annual caps or participation rates. There are lots of ways that they do it.
I pointed out, and the Council of Economic Advisors actually pointed out, that a huge sum of money was lost by the public because of one product, and that was this particular product. So if you don’t believe me, the Council of Economic Advisors, maybe believe them. It is a big problem.
Now, one of the things that you’ll find, though, is if you look at regulators. For example, in this particular case, they were talking about putting an annuity in an IRA. So here’s where if you go out, and last time I looked, it’s been a while since I’ve been on the SEC website, but if you go out there, they actually warn people about putting their IRAs in annuities or having an annuity IRA. They actually warn people about it.
And you go, “Well, wait a minute. Why don’t they just outright ban it?”
Because there can be a couple of instances where it can make sense. Now, you may be surprised to hear that from me because people think Paul hates annuities always. No, not if they’re used for what they were intended or what they were invented to be used for — as a distribution vehicle, which is basically where you run the money out, and as soon as you die, the money’s all gone.
That was really what they were designed to do. Now there are so many complexities. As a matter of fact, there was an article about that in MarketWatch, I think it was, The Wall Street Journal publication.
They were talking about how the more complex the annuity, the higher the commission.
So they confuse the daylights out of you, and the more confused you are, the more they make. They go, “Wait a minute, what’s wrong with this picture?”
But this is one of the things we find happening is the banks have got to find different ways to make money. One of the ways that they’re making money is with these commission-based products. And people are used to associating banks with no fees and no commissions.
They don’t think about it, that you are paying a big fee, a management fee on a CD, because it’s the differential between what they’re paying you and what they lend it back out at. And I think that confuses investors. We don’t like confused investors around here.
Advisory services offered through Paul Winkler, Inc an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.
